Banks on the run

Jayant Sinha (right), Minister of State for Finance, with Raghuram Rajan, RBI Governor, at the Gyan Sangam , at Gurgaon on March 4. Photo: Kamal Narang

Employees of IDBI Bank participating in a one-day nationwide strike against the move to privatise the bank, in Visakhapatnam on November 27, 2015. Photo: C.V. Subrahmanyam

Liquor baron Vijay Mallya, who has flown out of the country. Photo: VIVEK PRAKASH/Reuters

By refusing to make a significant commitment to recapitalise public sector banks, the government refuses to accept its own responsibility in causing the build-up of stressed assets in them. Instead, it sees in the crisis an opportunity to further its privatisation agenda.

A CLASSIC banking crisis is one in which there is a run on the bank, when customers lose their trust in the banking system. The current crisis facing the Indian banking sector is different: it is the banks that are on the run, chasing unscrupulous borrowers who have blown a gaping hole in their balance sheets. The Central government admitted in the Supreme Court on March 9 that the liquor baron Vijay Mallya, the “King of Good Times” who is wanted by not just a clutch of Indian banks but also the tax authorities, regulators and other enforcement agencies, apart from his former employees and customers, had flown out of the country a week earlier.

The crisis, euphemistically referred to as the NPA (non-performing assets) problem, has assumed a qualitatively new dimension in recent months. Finance Minister Arun Jaitley announced in Parliament recently that the gross NPAs of public sector banks amounted to Rs.3.62 lakh crore as on December 31, 2015. The statement implied that the NPAs in these banks increased by almost Rs.95,000 crore (or by more than one-third) in the nine-month period between April and December 2015. His deputy, Jayant Sinha, informed the Rajya Sabha that the top 30 accounts (the biggest NPA accounts of all those with outstandings above Rs.1 crore) accounted for more than half of the total NPAs among all commercial banks in India. The concentration of NPAs among a few chronic borrowers shows that political will is required to solve the problem.

Jaitley and his government’s excuse that NPAs were “legacy issues” left behind by the previous Congress-led United Progressive Alliance (UPA) government raises the question: what has the Narendra Modi government done to address the problem? Before the Union Budget was presented on February 29, the Chief Economic Adviser (CEA), Arvind Subramanian, suggested in the Economic Survey that the Reserve Bank of India (RBI) could use its reserves to recapitalise banks. Jaitley’s provision of Rs.25,000 for recapitalising banks is clearly inadequate, going by his Ministry’s earlier projection of the scale of requirement for the Indian banking system.

Capital for banks

It is widely perceived that the Ministry is using the CEA to take on the RBI Governor, Raghuram Rajan. It is useful to recall that the RBI chief had raised several objections over a period of time, of which it would suffice to illustrate two to show why the government may not be entirely comfortable with him. The Governor was among the first to counter Modi’s pet theme of “Make in India”. He pointed out that given the state of the global economy, the country may be better served by Make for India, referring to the need to establish and nurture domestic manufacturing linkages. Within a month after the lynching of a Muslim man at Dadri, Uttar Pradesh, in October 2015, Raghuram Rajan, going far beyond the call of duty, spoke about “the right to question and challenge, the right to behave differently so long as it does not hurt others seriously” (from his speech on “Tolerance and Respect for Economic Progress,” at the Indian Institute of Technology Delhi, on October 31, 2015).

Arvind Subramanian’s suggestion that the RBI fund the public sector banks’ recapitalisation is flawed on at least three counts. One, the foreign currency reserves of the central bank, currently valued at about Rs.23 lakh crore, are primarily meant to defend the rupee in a volatile world characterised by quick capital inflows and outflows. Given the realities of the post-2008 world, there is no way of knowing what an adequate reserve level ought to be. The suggestion that the RBI draw from its reserves could have serious implications; it could not only affect the exchange rate but have wider consequences for the economy. The only other option for the RBI is to partially liquidate its holdings of Rs.6 lakh crore of Indian government securities, which is plainly illogical because of the havoc it would cause in the bond market.

Secondly, those watching the financial markets have pointed out that the decline in the value of the dollar has reduced the return on assets that the RBI has parked in bonds (particularly United States Treasury bills) in the U.S. They point to the fact that the diminished rate of return on the RBI’s assets implies that a drawdown is not advisable from a financial returns standpoint.

However, the most important aspect of the fresh suggestion is that it runs counter to the logic the Central government used when it asked the RBI, in 2007, to divest its stake in State Bank of India (SBI). The reasoning then was that the RBI’s status as a regulator was incompatible with its role as an “owner” of a bank (SBI); this argument was pushed to pave the way for the RBI to divest 59.6 per cent of its stake in the biggest bank in India.

The former CEA, Ashok Lahiri, countered Arvind Subramanian’s suggestion that the RBI fund the recapitalisation of public sector banks. “There is no good reason to go back to [the] RBI acquiring stakes in the banks it regulates,” he wrote in an economic daily after the Budget presentation.

It appears that the CEA’s suggestion is based on two motives. First, given the government’s self-imposed commitment to keep the fiscal deficit on a tight leash, there is the motive of using some other source that is available to fund recapitalisation. The government’s track record confirms this reading. In 2014-15, capital infusion only amounted to Rs.6,990 crore, against a budgeted provision of Rs.11,200 crore. In fact, the 2015-16 Budget made a provision of Rs.7,940 crore for recapitalisation.

The gross under-provisioning towards recapitalisation, in the face of the massive build-up of NPAs in the banking system, appears to be motivated by the urge to use the problem to privatise banks. This would require public sector banks to go to the market by offloading equity, which in simple terms would be tantamount to privatisation. Jaitley has apparently started the business of offloading government stakes in right earnest, taking advantage of the weakest link in the chain, IDBI Bank. The bank is uniquely placed among government-owned banks in that it is outside the purview of the Bank Nationalisation Act, 1969, which would enable the government to bring its holdings from the current level of 80 per cent to below 50 per cent, an option not open to the government with other public sector banks.

More than 7,000 IDBI employees staged a spontaneous protest against the institution on its intranet and urged the Managing Director and CEO of the bank to protect it. One employee invoked the bank chief’s responsibility as “head of the IDBI family” to protect the institution. Referring to the notion that privatisation would make IDBI more efficient, another employee asked how “wilful and non-cooperative defaulters” could possibly transform it. The employees have not confined their protests to the online space; they are also planning to go on strike by March end, which is the busiest period in the banking calendar.

In any case, the dramatic fall in share prices in recent weeks and, most notably, those of banks, including major private banks such as ICICI and HDFC, clearly indicates that only a mala fide intent of selling them cheap could possibly explain the desperate urge to sell public sector bank equity. The dramatic slide in stock prices on the eve of the Budget resulted in the shares of many public sector banks hitting their 52-week low. In the case of IDBI, the government is planning to rope in “strategic” investors to help ensure “better valuations” to make a wider float of the institution’s share in the market possible. The extreme volatility in the stock market would suggest that this may be a reckless gambit.

At the recent Gyan Sangam II, the second edition of a retreat for bank chiefs both Jaitley and Sinha warned bank chiefs that they needed to “shape up”. Unlike during its first edition in Pune in 2014, in which Prime Minister Narendra Modi participated, this time bankers did not have the benefit of yoga to relieve them of the stress caused by “stressed assets” on their balance sheets.

Sinha said the magnitude of the problem of “stressed assets” in the entire banking sector (including private banks) could be a whopping Rs.8 lakh crore. He said the government had a “very good sense of the problem” and claimed that the situation had “stabilised”. He urged bank chiefs to assume “control” of NPAs and find ways to hasten the recovery of loans. Given that the loan books of all commercial banks is in the region of Rs.69 lakh crore, the stressed accounts account for almost 12 per cent of all loans currently outstanding.

The problem with this approach of those at the helm in the Finance Ministry is that it avoids responsibility for what has happened in the banking sector in the past few years. Pretending that this is a “legacy issue” left behind by the previous governments will not do, for the simple reason that it is government policy and RBI guidelines that have always allowed things to come to such a pass. A report of the Parliamentary Committee on Finance (chaired by M. Veerappa Moily), tabled in Parliament on February 24, specifically focussing on the NPA issue, has some insights to offer, even if many of these have been pointed out by economists, bankers and even RBI officials in the last few years.

The Moily report points to several features of the NPA problem: that the economic slowdown is a primary factor; that the NPAs are concentrated heavily in a few sectors such as textiles, aviation, steel, infrastructure, leather, jewellery; that a small number of heavy borrowers are responsible for a significant portion of the problem; and that the scale of the problem and losses to the banks are even bigger if “restructured” assets (loans that have been rescheduled or reconfigured) and stressed assets (loans that are in danger of slippage) are taken into account. The committee pointed out that gross NPAs combined with “restructured” assets accounted for 13 per cent of the loan books of public sector banks at the end of December 2014, a full two percentage points higher than the levels prevailing in March 2013. The committee observed that the pace of fresh NPA generation in the Indian banking sector accelerated significantly in the last couple of years—from 2 per cent in 2010-11 to 3.3 per cent in 2014-15.

Thomas Franco, senior vice-president of the All India Bank Officers Confederation (AIBOC), told Frontline that the accumulation of “restructured” assets in the banks’ books implied significant losses for the banks. He pointed out that the banks, in a desperate rush to “clean” their balance sheets, have passed on their loan portfolios at a discount to Asset Reconstruction Companies. A banking industry source told Frontline that, for instance, SBI sold its educational loan portfolio to Reliance Capital at a substantial discount, which implies that the bank would have to make provision for losses incurred from such loans.

Deposing before the Standing Committee, the RBI Governor said “malfeasance” was not a likely reason for the build-up of NPAs in the banking sector. He observed that public sector banks, unlike private banks, played a major part in lending to infrastructure projects, which have not taken off. The deposition of representatives of the Confederation of Indian Industry (CII), a prime industry lobby, sheds further light on why the scale of stressed assets piled up in the books of public sector banks. The CII pointed out that private participants in projects (especially those in public-private partnership mode) failed to bring in adequate equity; they had in a rush of enthusiasm exaggerated the benefits from projects, which did not materialise; they “over-leveraged” their balance sheets, meaning they borrowed more than they could chew! The RBI Governor also concurred with some of these observations, pointing out that “too little genuine equity” was brought in by investors to this project.

Neither the RBI nor the Finance Ministry has admitted that the binge in lending to such projects was made possible by directives from both agencies to banks asking them to loosen lending norms, especially limits, for such projects. Moreover, the fact that stagnation in industrial activity has been there for some time suggests that the Ministry and its policies have to bear a portion of the blame. If the steel industry could be given concessions to enable it to compete against imports, surely banks should be compensated for losses arising from guidelines, norms and policies initiated by the Ministry, Franco argued.

“The fact that senior officials from the Ministry are board members of every single public sector bank implies that they cannot walk away from the crisis as if they had nothing to do with it,” he observed. The excessive concentration of bad loans, and their build-up over time, surely suggests dereliction of duty by the Ministry. Speaking at Sangam II, Jaitley mooted the idea that Indian banking needs a round of mergers. It was suggested that the number of public sector banks be reduced to a manageable six or seven. Banking experts have pointed out that the idea, which former Finance Minister P. Chidambamam had also mooted, is not a great idea because banking is a specialised activity and banks have developed geographical and client linkages that can be ruptured by mergers. In any case, this would hardly be an opportune time to merge banks, especially when the extent of stressed assets is still not clear.

Jaitley’s measly allocation for bank recapitalisation is but a reflection of the government’s unwillingness to pay the bill for its own reckless pursuit of policies that have brought public sector banks to such a pass. Instead, the move to divest the government’s stake in government-owned banks marks a cynical attempt to use a crisis to cover up its own failure, and to use it as a pretext to throw them to the wolves.

According to the ILO’s latest report on global wages, growth in wages is falling even though GDP growth is improving and unemployment is on the decline. And this trend appears true of both developed and developing countries.